Does Huaibei Mining HoldingsLtd (SHSE:600985) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Huaibei Mining Holdings Co.,Ltd. (SHSE:600985) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Huaibei Mining HoldingsLtd

How Much Debt Does Huaibei Mining HoldingsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Huaibei Mining HoldingsLtd had CN¥11.5b of debt in September 2023, down from CN¥14.9b, one year before. However, because it has a cash reserve of CN¥10.1b, its net debt is less, at about CN¥1.38b.

How Strong Is Huaibei Mining HoldingsLtd's Balance Sheet?

The latest balance sheet data shows that Huaibei Mining HoldingsLtd had liabilities of CN¥26.3b due within a year, and liabilities of CN¥19.5b falling due after that. On the other hand, it had cash of CN¥10.1b and CN¥10.4b worth of receivables due within a year. So its liabilities total CN¥25.2b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Huaibei Mining HoldingsLtd is worth CN¥47.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Huaibei Mining HoldingsLtd's net debt is only 0.11 times its EBITDA. And its EBIT covers its interest expense a whopping 25.1 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Huaibei Mining HoldingsLtd saw its EBIT drop by 8.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Huaibei Mining HoldingsLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Huaibei Mining HoldingsLtd produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Huaibei Mining HoldingsLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that Huaibei Mining HoldingsLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Huaibei Mining HoldingsLtd that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.